I have more than 35 years’ experience as an attorney and financial planner, and I’ve worked with hundreds of business owners to solve problems, exit their businesses or retain their top talent. I work all over the country with financial advisors and business owners themselves to help them better prepare for their financial future. My blog is focused on financial intelligence for business owners. I'll talk about current events, experiences I've had with business owners, and a lot about taxes.
Steve is a National Advanced Solutions Director with the Principal Financial Group®, Des Moines, IA 50392. While this communication may be used to promote or market a transaction or an idea that is discussed in the publication, it is intended to provide general information about the subject matter covered and is provided with the understanding that the author is not rendering legal, accounting, or tax advice. It is not a marketed opinion and may not be used to avoid penalties under the Internal Revenue Code. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.
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What Happens If Interest Rates Go Up?

These days, the most common question I get from business owners is, “what happens if interest rates go up?” The question rarely has a follow-up with more specificity. Are they talking about lending rates or the return on their CDs? Are they talking short term or long term?

Apparently, it’s just a general nervousness that interest rates will go up, and this change will affect business — good and bad.

The Federal Reserve is being carefully watched as speculation rises that they are preparing to begin “tapering” its bond buying programs. The expected outcome is a general increase in interest rates. How much will they increase; will it have more effect on long or short term rates; and, how fast will it happen? All good questions, but ones without answers. Further, interest rates don’t work in a vacuum. Other economic and market conditions can offset the effect of an interest rate increase. All a business owner can do is seek good advice and begin to prepare for an increase in interest rates. Here are some considerations to factor into business planning.

Cost of Borrowing: The rise in interest rates question assumes that the cost of borrowing also increases. As the Fed’s bond buying slows, it becomes more expensive to borrow money, creating an increase in interest rates. This affects a business owner in a myriad of ways. To the extent your business is dependent on credit, your costs are likely to go up. There doesn’t appear to be an expectation that credit will become anymore available in the near term so you may want to factor in a net increase in costs.

Effect on Prices: It is overly simplistic to assume that with an increase in interest rates, there is a concomitant increase in prices. Sure, if a business owner’s costs go up because of borrowing, some or all of that cost may be passed on to the customer. But the economy doesn’t work in a linear way. Take a farmer, for example. Crops are a commodity, and commodity prices may actually fall with an increase in interest rates. Investors may start moving from commodities to financial instruments, generating a decline in crop prices, even as the farmer’s borrowing costs increase. The bottom line is a business owner should assess whether his or her business will allow for a related increase in prices to reflect higher interest rates.

Savings and Investments: Part of the current concern over bond prices is related to the expected increase in interest rates. As interest rates go up, the normal consequence is a drop in bond prices. Beyond this connection, it becomes more tenuous determining how savings and investments will trend. While some may argue that an increase in returns on fixed yield products will generate a flight to these kinds of savings vehicles, others would argue that the very reason the Fed is backing off on bond buying is because the economy is improving. With an improving economy, investors become more willing to invest in equities. Now is a particularly important time to discuss your savings and investment strategies with your financial advisor.

Overall Business Issues: An increase in interest rates can have a variety of business consequences that may affect your operations, including:

Receivables - Your cost of carrying credit for your customers may increase. It may be time to reconsider your receivables pricing policy.

Sales – How might a change in interest rates affect your sales? You may actually experience an increase in sales as customers try to access credit while it is still comparatively inexpensive. This may be particularly noticeable with capital purchases this year, as companies seek to access cheap credit AND utilize the current higher expensing rules under IRC 179. On the flip side, increased borrowing costs may cause a longer term slowing of purchases. More costs, less buying. This is an opportunity for you to consider a pricing strategy aimed at timing an anticipated change in rates.

Purchases - For the same reason your customers may change their buying habits, consider your own purchasing strategy. Is now the time to consider capital purchases or buying a large supply of goods needed for your manufacturing? Or, should you consider a cutback on purchases to reflect an anticipated dry spell in profits?

Marketing - The fact I’m being asked about interest rates is an indicator that this is an issue both on business owners’ and consumers’ minds. If you believe interest rates are on the rise, consider how you can build this into your marketing plan. Perhaps you should target customers who are most likely to be affected by this change. A “fire sale” approach for some; an easy credit approach for others.

There is no ready-mix approach to anticipating a change in interest rates. With all change though, it is likely to affect your business, so you might as well start planning for it now. I’m sure we’ll all be keeping a wary eye on this development going forward.

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I don’t think the Fed is tapering off spending because the economy is improving, I think they are tapering off because there comes a point that printing money either doesn’t work or becomes a major negative factor.

Does anyone actually in the workforce believe the economy is improving? I haven’t felt much but negativity for the past six years, and it certainly doesn’t feel much different now.

I keep wondering where the numbers on the “improvement” are coming from. Certainly not from jobs numbers, which one can argue are all that really matter. So where is this improvement exactly?

One can argue that there are some non-employment-related positives signs in the economy. That certainly is grist for the argument of tapering. But yes, one might also wonder if the Fed knows it needs to give the money printers a rest.